The Risks Facing Golub Capital BDC

What’s behind a BDC? In this 10-part series, we’ll peek under the hood of Golub Capital BDC, covering everything from the company’s history to its strategy to its balance sheet.

Jul 28, 2014 at 1:27PM

Source: Company.

As a lender, a BDC, and a firm with exposure to middle-market companies, Golub Capital BDC (NASDAQ:GBDC) faces a number of potential risks. Some of these are shared with its competitors and some of them are unique to the lending-based business model. 

In this installment of our in-depth analysis of Golub, we'll take a look at some of the key risks the company faces. 

The market 
Dealing with middle-market companies is inherently a risky proposition, for lenders and owners alike. Smaller companies might not have deep enough resources to cope with changing market environments, and growth can also be a source of weakness if it's too fast or outpaces infrastructure. 

These companies are simply more volatile than your average blue-chip. 

Golub credits its intense analysis process for its success, as there are obviously midsize companies that enjoy strong competitiveness and stability. It's the ability to select these companies and lend appropriately that determines whether a firm like Golub can be successful. The company's strategy sticking to mostly secured loans in an environment of easy money indicates a degree of level-headedness that I, for one, find appealing. I like my lenders predictable. 

It also helps that Golub tends to hold onto its loans, which introduces an added measure of risk into the loan origination process -- keeping loans on the books means you have to really think about whether your borrower will pay. I like this too. 

Interest rate risk 
Aside from who you lend to, the other risk in lending is the changing interest rate environment. Right now interest rates are low, but what happens if and when they go up again? 

Golub is partially reliant on the difference between the rates at which it can borrow and lend. Most of the firm's loans have floating interest rates, meaning that they'll rise with interest rates. But that isn't so profitable if Golub's borrowing costs also rise. Currently, Golub uses a combination of fixed and floating-rate loans and lines of credit to run its business. Though Golub hedges this risk to the extent they're allowed to, if interest rates change it's possible that the company could see compressed margins.

There is, of course, also a credit quality issue. If interest rates rise significantly, can Golub's borrowers continue to pay? One imagines that Golub takes these risks into account, but unforeseen circumstances can always come into play. 

Golub, like many of its peers, uses leverage to magnify returns.  

Leverage has the winning ability to make wins bigger; unfortunately, it can do the same to losses. There is also a cost to using leverage -- no one gets to borrow money for free -- and risks associated with easy access to it (the major risk being greed). 

By BDC rules, Golub is generally required to have a 200% coverage ratio on borrowings, meaning that for every $1 borrowed it needs to have $2 in assets. There are exemptions to this rule for some of its subsidiaries, so overall the firm's coverage ratio may be below 200%.

That's a pretty good coverage ratio, especially when you compare it to the large banks, but of course the risk remains. 

Risks related to shareholders
Finally, as a company that relies on shareholders for assets and performance income, Golub faces an additional set of risks. 

First off, there's obviously a need for shareholders to stick around and, ideally, keep adding money (given the income distribution requirement). If the market goes down and shareholders panic, they might suddenly decide to sell their shares (lower share price notwithstanding), possibly making it harder for Golub to invest effectively through a downturn. 

Secondly, there's a possible conflict of interest arising from the fact that Golub is paid an incentive fee, which means there's an incentive to push valuations and returns higher in order to boost compensation. While it doesn't look like any of that is happening, it's an important risk to be aware of when investing in BDCs.

Next Time: A look at the BDC industry and Golub's competitors. 

Risk-free for 30 days: The Motley Fool's flagship service
Tom and David Gardner founded The Motley Fool over 20 years ago with the goal of helping the world invest...better. Their flagship service, Stock Advisor, has helped thousands of investors take control of their financial lives and beat the market. Click here to sign up today.

Anna Wroblewska has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.

Compare Brokers